BANK OF ENGLAND: DEFLATION IS COMING

The Bank of England’s latest inflation report is out, and you can sum it up in two words: Dovish and deflation.‎ They’re saying UK inflation is more likely than not to turn negative in a few months time, and that no interest hike is on the horizon.

Since inflation is now below 1%, Governor Mark Carney also had to write a letter to Chancellor George Osborne explaining why that’s the case.

Here’s a breakdown of their main forecasts:

2015 growth forecast at 2.9%, no change from the last conference

2016 growth forecast at 2.9%, up from 2.6%

Inflation is forecast at 0% in Q2 and Q3 this year, with a likely month or two of deflation during the summer

Inflation won’t return to 2% until the end of 2017

Oil prices will sit at around $US58 this year, $US65 next year and $US69 the year after

Falling unemployment‎ will slow down. The bank expects 5.4% unemployment this year, 5.2% next year and 5% in 2018

Carney’s letter says that the Bank is putting two thirds of the drop in inflation can be put down to energy, food and goods prices. They’re pretty relaxed about that, but unlike the US Federal Reserve (which currently looks set to hike rates during the summer), it doesn’t sound like they’re planning to raise interest rates any time soon.

A BoE press officer says inflation will “more likely than not” slump below zero in the summer. But they’re expecting that to be brief.
Here are two important sections from Carney’s letter:

“Inflation is below the target while unemployment is above its long-run sustainable rate. There is therefore no immediate trade-off between returning inflation to the target and supporting economic activity. In fact, to return inflation to target it is necessary to eliminate the remaining degree of economic slack. It is therefore appropriate to return inflation to the target as quickly as possible after the effects of energy and food price movements have abated…”

“The MPC (Monetary Policy Committee) judges it likely that, within two years, conditional on interest rates following the path currently implied by market yields, slack in the economy will be absorbed and inflation will return to the 2% target”
The market is pricing a very slow increase in rates starting in the first half of 2016. Just six months ago, serious economists were suggesting that the bank would already have hiked rates by now. Most of the rest were suggesting a hike in the first half of this year. There is pretty much zero hint at an early rate hike any more.
Dovish, dovish, dovish.

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